60.1K

Verified Solution

Link Copied!

Royal Financial Services (RFS) provides front end loan origination services for a number of banks who process and maintain loan portfolios. RFS accepts applications from customers and processes them through closing of the loan agreement before turning the loan over to customer banks. RFS is paid regardless of whether the loan closes or not. RFS currently services three types of loans - residential mortgages, auto loans, and personal unsecured loans. RFS has no cost accounting system so total operating expenses are simply allocated to each product line based on revenue. RFS management is concerned about the overall low profitability of the business and has asked you to apply activity-based analysis in order to give RFS a better understanding of relative product profitability. You determine that the application processing and loan analysis activities are performed using internal RFS resources while the credit and closing activities are performed primarily by external credit agencies and law offices on a per transaction basis (e.g. $X per credit check, $Y per closing hour). You also learn 70% of the mortgages end up being closed (the remainder are not approved after loan analysis); 80% of auto loans close and 90% of personal loans close. You also identify a key external measure of how well RFS is performing versus the industry. While RFS does not bear the cost of defaults, their customers do track RFS performance and use it to negotiate future origination fee rates.

Revised ABC Income Statement		Mortgage	Auto	Personal
Total Revenues		$ 525,000	$ 1,200,000	$ 460,000
Operating Expense	Accept applications	308000	231000	77000
	Obtain credit referrals	133000	133000	66500
	Do loan analysis	328000	218667	109333
	Close loan	283371	141686	70843
	Total Oper Exp	1052371	724352	323676
Profit		-527371	475648	136324
Profit % Revenue		-100.5%	39.6%	29.6%
		Mortgage	Auto	Personal
Default rate experienced by loan processor		2%	1%	6%
Industry average		2%	3%	4%
Per Unit		Mortgage	Auto	Personal
Total Revenues		$ 175,000	$ 1,200,000	$ 460,000
Operating Expense	Accept applications	$ 102,667	$ 77,000	$ 25,667
	Obtain credit referrals	$ 44,333	$ 44,333	$ 22,167
	Do loan analysis	$ 109,333	$ 72,889	$ 36,444
	Close loan	$ 94,457	$ 47,229	$ 23,614
	Total Oper Exp	$ 431,333	$ 241,451	$ 107,892
	Profit	$ (256,333)	$ 958,549	$ 352,108

Summarize and Make specific recommendations to RFS to improve business profitability.

Answer & Explanation Solved by verified expert

See Answer